CLIMATE ADAPTATION GUIDE FOR ASSET OWNERS: RISK … · IUCN NL: Romie Goedicke Next Green: Anne-Marie Bor . This report is part of a series in which WWF provides insights and recommendations

CLIMATE ADAPTATION GUIDE FOR ASSET OWNERS: RISK MITIGATION AND OPPORTUNITY REALIZATION

2020

REPORTNL

www.wwf.nl

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°Authors Gerhard Mulder (Climate Risk Services) Stephanie Gnissios (Climate Risk Services) Nicolas Poolen (WWF-NL) Jorien van Hoogen (WWF-NL)

WWF Contributors

WWF European Policy Office: Jan Vandermosten WWF Netherlands: Aaron Vermeulen WWF Netherlands: Anne te Molder WWF United States: Shaun Martin WWF Climate and Energy Practice: Chris Weber & Sandeep Chamling Rai WWF Singapore: Adrian Fenton WWF Hong-Kong: Sam Hilton WWF Finance Practice: Joanne Lee

WWF would like to acknowledge contributions from the following stakeholders and thank

them for their valuable inputs:

VBDO: Jacqueline Duiker Korea Investment Corporation: Jinsuk Choi Achmea Investment Management: Thiery Oeljee APG: Derk Welling Zurich Insurance Group: Johanna Koeb Nordea Life & Pension: Peter Sandahl & Cecilia Kellner PGGM: Piet Klop Actiam: Arjan Ruijs Climate Fund Managers: Darren Moens MN Services: Mark de Nooij IUCN NL: Romie Goedicke Next Green: Anne-Marie Bor

This report is part of a series in which WWF provides insights and recommendations for asset

owners on how to respond to climate change. You can find the full list of publications here.

The views expressed in this publication are the sole responsibility of WWF and do not necessarily

reflect the views of the above stakeholders. The authors are solely responsible for any errors.

Disclaimer: This publication and related materials are not intended to provide and no constitute financial or investment advice. WWF makes no representation regarding the advisability or suitability of investing in any particular company, investment fund or other vehicle or of using the services of any particular entity, pension provider or other service provider for the provision of investment services. A decision to use the services of any pension provider, or other entity should not be made in reliance on any of the statements set forth in this publication. Whilst every effort has been made to ensure the information in this publication is correct, WWF and its agents cannot guarantee its accuracy and the shall not be liable for any claims or losses of any nature in connection with information contained in this document, including (but not limited to) lost profits or punitive or consequential damages or claims in negligence.

Graphic design: Onehemisphere, Sweden. [email protected] Cover photo: Aerial view of fish ponds in Mai Po Nature Reserve. Shenzen City in background. Hong Kong. © Martin Harvey / WWF.

This document has been published under the Shared Resources, Joint Solutions (SRJS) program, a strategic partnership between IUCN NL, WWF NL and the Netherlands Ministry of Foreign Affairs. SRJS supports the capacity of local NGOs and civil society organizations in sixteen low- and middle-income countries. The program aims to ensure climate resilience, water supply and food security by joining forces with the public and private sector.

Published in 2020 by WWF – World Wide Fund for Nature, Netherlands, Zeist. Any reproduction in full or in part must mention the title and credit the above-mentioned publisher as the copyright owner. © WWF 2020. All rights reserved.

https://www.wwf.eu/what_we_do/sustainable_economies/working_with_investors/

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WWF - Climate adaptation guide for asset owners: Risk mitigation and opportunity realization | 4

Asset owners are increasingly developing strategies to identify and manage risks from physical climate hazards as well as risks stemming from the transition to a low-carbon economy. Yet, the financial sector is still far from treating climate risk as a material risk which drives valuations of companies and assets or investment decisions. To date, efforts to address climate change or manage climate risk have mainly focused mostly on mitigation.

Climate Adaptation is the process of adjusting to actual or expected changes in climate and its effects. Climate adaptation is relevant for asset owners because through their portfolios they are directly (e.g. extreme weather events damaging portfolio companies) and indirectly (e.g. supply chain disruptions of portfolio companies) exposed to climate change risk. The investments required can rise to USD 500 billion per year by 2050; done correctly, it is also an opportunity to safeguard and restore nature.

To build climate resilience, adaptation measures must take a systemic view. Focusing exclusively on economic and social priorities can result in the unintentional degradation of natural systems and natural capital, undermining long-term resilience of people, and livelihoods. This in turn will have a negative impact on economic development. WWF advocates that adaptation efforts include the use of landscape approaches and focus on establishing social-ecological resilience by ensuring that adaptation efforts avoid harming nature, use nature to help people, and help nature adapt also.

Engaging in climate adaptation offers asset owners the opportunities to mitigate risk and identify new investment opportunities. There are increasingly means to increase exposure to “good” climate adaptation interventions; indirectly, through portfolio entities’ adaptation to climate change, or directly, through dedicated channels including Adaptation-Themed Green Bonds, Availability-Based Payments in Public-Private-Partnerships and Climate-Themed Investment Funds. These channels are not new, but in practice can be scaled and expanded as prioritized investment opportunities to foster climate adaptation, particularly into emerging markets.

WWF offers seven recommendations for asset owners to channel investment into instruments that are widely understood by the investment community while bearing in mind that asset owners may have to review their mandate to capitalize on them. Acting on these recommendations will enable asset owners to build a deeper understanding of climate risk and the value of adaptation to mitigate risk and realize new value creation opportunities.

WWF RECOMMENDATIONS AT A GLANCE

ADAPTATION COSTS COULD RISE TO

USD 500 BILLION PER YEAR BY 2050


RECOMMENDATIONSAT A GLANCE

Educate across the organization on climate risks and climate adaptation

Set a risk appetite for climate risk and develop tools to monitor investees

Develop decision-making factors that promote good adaptation strategies

Establish partnerships to gain a deeper understanding

Establish partnerships to create markets for sustainable infrastructure

Revise investment mandates to integrateor even prioritizeadaptation opportunities

Engage with portfoliocompanies to achieve climate resilience

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MONITORING SERVICE PROVIDERS AND ENGAGING WITH KEY STAKEHOLDERS

RECOMMENDATIONS


1.INTRODUCTION

Despite continuing efforts to slow the rate and degree of human-induced climate change, its impacts are unavoidable and increasing. Climate change has become a megatrend that can disrupt markets, dislocate communities, and have devastating impact on nature and biodiversity.

Since the Earth Summit in 1992, efforts to tackle climate change have focused mainly on mitigation. As recently as 2018, adaptation efforts accounted for just 5%, or USD 30 billion, of USD 579 billion in tracked climate finance from both private and public finance sources.1 It has been widely believed that each Euro or Dollar spent on climate should be focused on preventing climate change from happening rather than adapting to it. This was compounded by the conviction that climate change was a ‘future problem’. Not anymore. Climate hazards such as extreme temperatures, off seasonal and increased weather extremes such as heatwaves, droughts, floods and heavy storms are increasingly impacting society and the economy and are expected to increase exponentially as the rate of CO2 emissions is still growing.2 This will have an extensive impact on people and nature, and the international investment community is increasingly recognizing the need to place more of a focus on adapting to a changing climate.

The need for climate adaptation is global, but the effects of climate change are unevenly distributed and experienced differently by developed and developing countries. Developing countries may struggle to adapt more than developed countries, with less adaptive capacity and lower access to capital. According to a 2016 report by the United Nations Environmental Programme (UNEP), the costs of adaptation in developing countries could range from USD 140 billion to USD 300 billion per year by 2030.3 At the global scale, costs are likely to be between USD 280 billion and USD 500 billion per year by 2050, with even higher costs possible under higher emissions scenarios.

Natural capital plays a critical role in mitigating and adapting to climate change and loss of natural capital. Unsustainable practices compounded by human-induced climate change pose direct risks to the economy. Natural capital includes resources and systems such as water, forests, and clean air, which enable economic activity by providing businesses with materials, production inputs, protection from natural disasters, and absorption of emissions. Thus, a decline in natural capital affects asset owners directly as portfolio companies depend on natural capital to operate and meet performance targets. As institutional investors in the private sector, and often with exposure to the whole economy, asset owners hold a key role in addressing risks and promoting solutions, while ensuring the delivery of meaningful commitments.

1 Climate Policy Initiative (2019), Global Landscape of Climate Finance 2019. 2 NOAA Global Monitoring Laboratory, Boulder, Colorado, USA. Retrieved from

https://www.esrl.noaa.gov/gmd/ccgg/trends/gl_gr.html 3 UNEP (2016), The adaptation finance gap report.

THE NEED FOR CLIMATE ADAPTATION IS GLOBAL,

BUT THE EFFECTS OF CLIMATE CHANGE ARE

UNEVENLY DISTRIBUTED AND EXPERIENCED

DIFFERENTLY BY DEVELOPED AND

DEVELOPING COUNTRIES

https://www.esrl.noaa.gov/gmd/ccgg/trends/gl_gr.html


Demand is growing for climate-resilience products and services, including new materials, engineering techniques, early warning systems, information tools, and climate and weather data. These investment opportunities will present themselves through multiple channels. There will be a significant increase in climate adaptation themed Green Bonds in the future (see Chapter 5); there will be an increase in listed and unlisted climate resilient infrastructure assets; and new partnership opportunities will emerge as governments provide de-risking instruments.

This report will start with a discussion on climate risk for asset owners, and how climate adaptation relates. An overview of climate adaptation is followed by a discussion on how climate adaptation offers opportunities to mitigate risk and access new value streams. The focus will then shift to opportunities for engagement: how can asset owners allocate capital to finance adaptation? The report will highlight instruments and investment vehicles which are currently available, discuss how asset owners can build cross-industry coalitions to create new markets for investment-scale adaptation projects, and how the role of Multilateral Development Banks (MDBs) and Development Finance Institutions (DFIs) is changing to allow for more institutional funding to enter the market. The report will also highlight other relevant trends, such as how nature-based solutions are emerging as a promising approach and the importance of partnerships at the local level. The report will conclude with concrete recommendations on how to act.

DEMAND IS GROWING FOR

CLIMATE-RESILIENCE PRODUCTS AND

SERVICES

INTRODUCTION


CONTENTS1. INTRODUCTION 6 2. CLIMATE RISK FOR ASSET OWNERS 10 What is Climate Risk? 10 Why Should Asset Owners Take Notice? 12 How to Proceed? 16 3. CLIMATE ADAPTATION 18 What is Required and Who is Responsible? 19 WWF and Climate Adaptation 20 4. RISK MITIGATION & VALUE CREATION 23 Natural Capital and the Economy 23 The Case for Adaptation 24 Risk Mitigation through Climate Adaptation 24 Value Creation through Climate Adaptation 25 5. ENGAGING IN CLIMATE ADAPTATION INVESTMENTS 28 Direct and Indirect Exposure 28 Building New Markets: The Role of Government 29 Climate Adaptation for Emerging Markets 29 Investing in Climate Adaptation: EU Taxonomy 30 Channel 1: Adaptation-Themed Environmental Bonds 31 Channel 2: Availability-Based Payments in Public-Private-Partnerships 33 Channel 3: Climate-Themed Investment Funds 36 6. RECOMMENDATIONS FOR ASSET OWNERS 40

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4 VBDO (2019), Dutch institutional investors and climate change – becoming part of the solution. Retrieved from https://www.vbdo.nl/en/2019/11/dutch-institutional-investors-and-climate-change-becoming-part-of-the-solution/

5 NASA’s Scientific Visualization Studio (2020), Global Temperature Anomalies from 1880 to 2019. Data provided by Robert B. Schmunk (NASA/GSFC GISS). Retrieved from: https://svs.gsfc.nasa.gov/4787

6 Global Commission on Adaptation (2019) Adapt Now: A global call for leadership on climate.

7 The Task Force for Climate-Related Financial Disclosure (TCFD) defines these three categories of transition risk.

CLIMATE RISK FOR ASSET OWNERS Asset owners are starting to develop strategies to identify and manage risks from climate change as well as risks stemming from the transition to a low-carbon and climate resilient future.4 Yet, the financial sector is still far from treating climate risk as a material risk which drives valuations of companies and assets or investment decisions. Furthermore, many asset owners currently equate climate risk with the carbon intensity of their investment portfolio. While this may be an important measure of the transition risk in a portfolio (as companies may be subject to carbon pricing), asset owners should expand their view to include other factors which cover both physical and transition risk, with an understanding of how the two aspects interact.

WHAT IS CLIMATE RISK? Climate risk is often categorized as either physical or transition risk.

Physical risk can be understood as physical impacts caused by the Earth’s changing climate. This is most commonly discussed as a rising average global temperature. The planet’s average temperature has risen by about 1.1°C since the 1880s.5 This rate of warming is at least an order of magnitude faster than any found in the past 65 million years.

However, increasing global temperatures also affect a wider range of planetary conditions. Along with increasing temperatures, physical climate hazards include rising sea levels, increased frequency and intensity of rainfall and extreme weather events, temperature extremes, drought, and increased likelihood of wildfires. The Global Commision on Adaptation emphasizes “the effects of climate change will most immediately and acutely be expressed through water”.6 Although these hazards clearly impact human and physical capital, climate change also has major impacts on ecosystems causing chronic degradation of natural resources such as glaciers, forests, and ocean ecosystems, which provide important services to the economy and people. This in turn imperils the human habitat and economic activity over a longer time horizon.

Transition risk relates to changes in policy and regulation, shifting markets and technologies, and reputational risks associated with transitioning to a more climate resilient economy.7 Policy and regulatory changes have been part of the response to climate change since the 1992 Earth Summit in Rio de Janeiro, where the United Nations Framework Convention on Climate Change (UNFCCC) was adopted. Markets and technology risk factors arise from increasing efforts to transition to a low-carbon economy, with reputational and liability risks arising from shifting socio-cultural values and broader social movements.

“THE EFFECTS OF CLIMATE CHANGE WILL MOST

IMMEDIATELY AND ACUTELY BE EXPRESSED

THROUGH WATER”

The Global Commission on Adaptation

https://www.vbdo.nl/en/2019/11/dutch-institutional-investors-and-climate-change-becoming-part-of-the-solution/https://www.vbdo.nl/en/2019/11/dutch-institutional-investors-and-climate-change-becoming-part-of-the-solution/https://svs.gsfc.nasa.gov/4787

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Although physical and transition risk are often considered separately, an integrated and systemic view is necessary to truly understand climate risk exposure. For example, a common focus of climate risk is scarcity of water resources. As the atmosphere warms, hydrological cycles are affected and the frequency, volume, form, and intensity of precipitation changes. Water intensive industries (such as mining, agriculture, or food and beverage companies) which are often operating in high risk areas can expect increasing competition for water resources as the climate changes. As a result, the physical hazard of water scarcity may be compounded by transition risk due to new regulations designed to protect water availability and quality, public health, and safety.

CLIMATE RISK FOR ASSET OWNERS

MITIGATION

ADDRESSINGEMISSIONS

CLIMATEADAPTATION

ADDRESSINGCLIMATE CHANGE

EMISSIONS

CO2

CLIMATECHANGE

FIGURE 1 CLIMATE CHANGE MITIGATION AND ADAPTATION*

BOX 1. WWF WATER RISK FILTER Launched in 2012, the WWF Water Risk Filter is a practical, online tool that helps companies and investors assess and respond to water-related risks facing their operations, supply chains and investments across the globe. The Water Risk Filter Version 5.0 is unique in its ability to combine basin and operational water risk to provide recommended response actions and evaluate how water risk can affect financial value. To help companies and investors in their strategic and long-term planning in the context of climate change, WWF is in the process of integrating climate and socio-economic pathway-based scenarios into the tool to support scenario evaluation of water risks and resilience in line with the Task Force for Climate-related Financial Disclosure (TCFD) recommendations.

*Adapted from VBDO.


WHY SHOULD ASSET OWNERS TAKE NOTICE? A 2015 report by The Economist estimates the value-at-risk (VaR) to the year 2100 at USD 4.2 trillion in present value terms, as a result of climate change impacts on the total global stock of manageable assets.8 The Bank of England warned in 2019 of a “climate Minsky moment” where asset prices may adjust quickly and cause losses as high as USD 20 trillion.9

Most analysis is based on the average (mean) expected loss; but the VaR calculation should include a wider range of scenarios, and tail risks are far more serious. The current business-as-usual trajectory (or RCP8.5 as defined by the IPCC) puts the world on a path of 4°C warming by 2100, based on the expected concentration of CO2 in the atmosphere by 2100. There is significant uncertainty about how temperature responds to the concentration of atmospheric CO2, or the so-called “climate sensitivity”. There is also a small (10°C

FIGURE 2 DISTRIBUTION OF RISK OF TEMPERATURE RISE BY 2100

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GLOBAL TEMPERATURES ARE ON COURSE TO EXCEED THE UN TARGET

0 1 2 3 4 5

INCREASE IN GLOBAL TEMPERATURE (°C)

+1.0°C +1.5°C +2.9°C +3.2°C

Increase since pre-industrial times

as of 2018

Paris Agreementmost ambitious

target

2100 outlookunder pledged

actions

2100 outlookunder current

policies

HEATING UP

FIGURE 3 RISING GLOBAL TEMPERATURE*

Climate physical risks are created by a range of critical hazards, such as:Wildfires/storms & hurricanes/coastal and riverine flooding/extreme weather/drougts/water stress.

PHYSICAL CLIMATE RISK

Asset owners’ operations may be disrupted due to the physical damage to its properties, branches or data centers. Depletion of natural capital by portfolio companies can lead to reputation and liability risks for the asset owner.Operational risk

Credit risk

Market risk

Regulatory risk

Climate change impact on natural capital may lead to higher (commodity) prices, leading to higher costs and lowervaluations. This may impact probabilities of default (PD) and Loss Given Default (LGD), for example, through lowercollateral valuations.

As concerns about climate change, biodiversity loss, and natural capital depletion increases, shifts in consumer behaviour could result in sudden repricing, higher volatility and losses in asset values.

Climate change may lead to an increased competition for natural resources, including water, leading to increased regulatory risk.

FIGURE 4 CLIMATE RISK FOR THE FINANCIAL SECTOR

*Source: Climate Action Tracker (climateactiontracker.org/global/temperatures/). Figures as of September 2019. Outlooks for 2100 are median estimates.

https://climateactiontracker.org/global/temperatures/


10 IFR (2020), ESG ratings to the fore as bond investors step up scrutiny. Retrieved from https://www.ifre.com/story/2246086/esg-ratings-to-the-fore-as-bond-investors-step-up-scrutiny-mq7c6fycjq

11 The Task Force on Climate-related Financial Disclosures (TCFD) develops voluntary, consistent climate-related financial risk disclosures for use by companies in providing information to investors, lenders, insurers, and other stakeholders. It was established by the Financial Stability Board (FSB), which is part of the G20. See: www.fsb-tcfd.org

12 Financial Times (2019), Third of biggest banks fail to sign up to climate initiative. Retrieved from https://www.ft.com/content/0eec5a1e-ee99-11e9-ad1e-4367d8281195

All asset owners are exposed to climate-related risks in the context of traditional industry risk categories such as credit risk, operational risk, market risk, and regulatory risk. Credit risk may arise as the ability of each individual company (or governmental entity, authority, municipality, county, state or nation) to pay the interest and principal on its debt can be impacted by climate change. The global nature of climate change means that the aggregated impact of climate hazards leading to credit risk across a portfolio could ultimately generate liquidity risk for the asset owner, even in a well-diversified portfolio. Major rating agencies are starting to incorporate climate risk into their credit risk assessment, but investors should form their own judgement as to whether this is done sufficiently.


BOX 2. CREDIT RISK Miami’s sea level has risen by 3.5 inches since 1992 and is projected to rise another 14 to 26 inches by 2060. The city already experiences regular high-tide flooding, even on clear, sunny days. Yet, in April 2019 Miami Beach raised a USD 162 million general purpose bond with 20 year maturity priced at the same yield as a similar April offering by Charlotte, North Carolina, an inland city with much less climate risk. Both issues had the same ratings from Moody’s and S&P.

Asset owners can run operational risk as well, realizing interruptions or damages due to climate risk. Physical climate hazards may cause infrastructure and technology failures or loss, inaccessible premises interrupting the normal course of business, loss of life or reduced productivity of personnel, or failure to deliver from third party key service providers. Reputational risk also has a role to play. As the sustainable finance movement accelerates, asset owners are facing increasing scrutiny on how environmental, social, and governance (ESG) ratings play a role in investment decisions. In February 2020, one of Europe’s leading investors walked away from a conventional Euro bond deal for a United States real estate company with a low ESG rating.10 Support for the recommendations of the Task Force for Climate-Related Financial Disclosures (TCFD)11 is growing, with increasing interest in which banks and investors are not endorsing the initiative.12

BOX 3. OPERATIONAL RISK In 2012 Hurricane Sandy shut down Wall Street for several days, but the headquarters of Goldman Sachs was unharmed. It was designed with a lot of redundancy and it had on-site back-up power.

https://www.ifre.com/story/2246086/esg-ratings-to-the-fore-as-bond-investors-step-up-scrutiny-mq7c6fycjqhttps://www.ifre.com/story/2246086/esg-ratings-to-the-fore-as-bond-investors-step-up-scrutiny-mq7c6fycjqwww.fsb-tcfd.orghttps://www.ft.com/content/0eec5a1e-ee99-11e9-ad1e-4367d8281195


Opportunity Beckons and Leadership Calls, Rotman, International Pensions Management Journal, Spring 2011.

14 UNEP (2019), Environmental Rule of Law: First Global Report.

13 Universal Owners are large institutions investing for the long-term in widely diversified holdings across multiple industries and asset classes, thus exposed to the entire market and economy. As defined by Urwin, R. (2011), Pension Funds as Universal Owners;

Market risk may be the most prominent risk for asset owners. The combination of physical and transition risks can cause short-term volatility as well as long-term economic risk. Acute physical climate hazards may affect regionally concentrated markets or cause significant uninsured losses. Over time, longer-term climate changes may affect the viability of whole sectors or require significant investment to reimagine or re-locate the sector. While all asset owners are exposed to market risk, this holds particularly true for Universal Owners13 as climate change is a systemic investment risk that cannot be diversified away. The financial stability of the whole system is at risk.


BOX 4. MARKET RISK The meat sector is starting to feel the impact of changing consumer behavior and stakeholder pressure. Meat production is major contributor to climate change and is associated with deforestation in countries like Brazil. Consumers are increasingly embracing ‘alternative proteins’, such as plant-based burgers. The value of the plant-based meat market across the globe is forecast to grow at a CAGR of 15 percent between 2018 and 2026. Companies that do not adjust their strategy may be losing market share and see profits drop.

Asset owners are subject to regulatory risk from all levels of the policy landscape. For example, regulators such as central banks are proposing stringent supervisory expectations that will require asset owners to update their risk management frameworks to include climate and environmental risk. Central Banks have been at the forefront of new regulations to manage climate risks. In 2019, the Bank of England announced a climate stress test, requiring financial institutions to incorporate three different environmental scenarios into normal annual stress testing. In May 2020 the European Central Bank (ECB) published a consultation document with its supervisory expectations for financial institutions across the Eurozone and participating Member States in the Single Supervisory Mechanism (SSM). These supervisory expectations are expected to set a new global standard on how financial institutions manage climate risk. But asset owners are exposed to local regulatory risks as well through their portfolio companies. Since 1972, there has been a 38-fold increase in environmental laws put in place, although enforcement remains a challenge in many jurisdictions.14 More stringent local environmental policies will increase compliance costs or in the worst case may lead to a loss of a company’s operating license.

BOX 5. REGULATORY RISK Central banks see carbon pricing as one of the main tools to internalize the climate externalities. However, the Bank for International Settlements (BIS) also notes that carbon pricing schemes have not been implemented at a level sufficient to drive capital reallocation from “brown” (or carbon-intensive) to “green” (or low-carbon) assets. A quick ramping up of carbon pricing may lead to “stranded assets”.


15 UNFCCC (2015), The Paris Agreement. 16 See a complete list of financial institutions committed to SBTi at

https://sciencebasedtargets.org/companies-taking-action/

HOW TO PROCEED? Understanding climate risk is of importance to asset owners on several levels. Identifying, prioritizing, and managing climate risk will allow asset owners to:

• Enhance risk management and develop a better understanding of the strategic impact of climate change on creating and protecting long term value for its beneficiaries;

• Create a framework for constructive dialogue between all elements of the investment chain. Understanding climate risk will allow asset owners to work with asset managers to thoroughly assess the financial impacts of physical risks and transition risks, as well as the opportunities resulting from climate change. This can enhance an asset manager’s dialogue with investee companies and encourage them to focus on long term value creation that benefits social, physical, and natural capital.

Yet, ultimately, what regulators and Chief Risk Officers want to know is the financial VaR, including Probability of Default and Loss Given Default. More needs to be done to integrate climate risk into the valuation of companies.

Although many asset owners have started work to identify, prioritize, and manage climate risk, no asset owner has a silver bullet and all are experiencing a learning curve due to the nature of climate risk. It is therefore important to develop an “adaptive management” approach: making decisions and adjustments in response to new information and changes in context. Adaptive management is not about changing goals during implementation, but about changing the path to achieving the goals in response to changes. As part of an adaptive management approach, asset owners can look to investing in climate adaptation as part of a risk management strategy, and as an opportunity to build value.


BOX 6. ALIGNING PORTFOLIOS WITH THE PARIS AGREEMENT One of the goals of the Paris Agreement is to make “financial flows be consistent with a pathway towards low greenhouse gas emissions and climate-resilient development”.15 In 2018, WWF and several partners, including the World Resources Institute and the UN Global Compact, started the Science Based Targets initiative (SBTi). SBTi translates the carbon budget into individual targets on company and sectoral level. These targets apply to companies’ direct emissions (known as scope 1), emissions from the electricity they buy (known as scope 2), but also for all significant emissions across the value chain (known as scope 3). The SBTi launched a project to help financial institutions align their lending and investment portfolios with the ambition of the Paris Agreement. The project audience includes universal banks, pension funds, insurance companies and public financial institutions. As of February 2020, more than 50 financial institutions have publicly committed to setting targets through the SBTi.16

https://sciencebasedtargets.org/companies-taking-action/

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17 IPCC (2018), Special Report on Global Warming of 1.5 °C. 7: Glossary. 18 IPCC (2018), Special Report on Global Warming of 1.5 °C. 7: Glossary.


3.CLIMATE ADAPTATION

The UNFCCC and the agreements that followed have always made a distinction between climate change mitigation and climate change adaptation.

Mitigation: Involves a human intervention to reduce the sources of greenhouse gases (for example, the burning of fossil fuels for electricity, heat or transport) or to enhance the sinks of greenhouse gases (such as the oceans, forests and soil).17

Adaptation: Involves the process of adjustment to actual or expected changes in climate and its effects. In human systems, adaptation seeks to moderate or avoid harm or exploit beneficial opportunities. In some natural systems, human intervention may facilitate adjustment to expected climate and its effects.18

The concept of climate risk is gaining more and more attention, particularly in the financial sector, although the term has been used by the IPCC since its inception. It relates to climate adaptation and mitigation in the sense that a proper risk assessment should inform a range of activities which may build climate resilience (the capacity of a system to withstand and recover from risk events) through mitigation or adaptation action.

Although climate risk is typically discussed as threat management, a proper risk assessment should also identify opportunities. Indeed, the changing climate also offers opportunities to identify new streams of value creation. An integrated approach incorporating climate risk and climate opportunity to achieve both mitigation effects and adaptation effects can yield benefits including risk mitigation, increased opportunities, enhanced resilience and loss avoidance, and identification of new streams of value creation.

ALTHOUGH CLIMATE RISK IS TYPICALLY DISCUSSED

AS THREAT MANAGEMENT, A PROPER RISK

ASSESSMENT SHOULD ALSO IDENTIFY

OPPORTUNITIES

MITIG

ATION

EFFE

CTS

Climate Risk

Climate Opportunity

Risk mitigationEnhanced

resilience & loss avoidance

Increased positive opportunities

New streams ofvalue creation

Climate Mitigation Climate Adaptation

ADAPTATION EFFECTS

FIGURE 5 RELATING CLIMATE RISK AND OPPORTUNITY ACROSS CLIMATE MITIGATION AND ADAPTATION

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19 The Commission is led by Ban Ki-moon, 8th Secretary-General of the United Nations, Bill Gates, and Kristalina Georgieva, CEO, World Bank.

20 FAO (2008), Climate change and food security: A framework document. P. 25, Table 1B. 21 Bloomberg (2016), Louisiana’s Sinking Coast Is a $100 Billion Nightmare for Big Oil.

Retrieved from https://www.bloomberg.com/news/features/2016-08-17/louisiana-s-sinking-coast-is-a-100-billion-nightmare-for-big-oil

WHAT IS REQUIRED AND WHO IS RESPONSIBLE? The Global Commission on Adaptation,19 an initiative of the Global Centre on Adaptation and the World Resources Institute, has identified several key systems that are affected by climate change: systems that produce food, protect and manage water and the natural environment, plan and build our cities and infrastructure, protect people from disasters, and provide financing for a more resilient future.

A systemic view is critical to understanding and addressing the need for climate adaptation. FAO offers the example of an increasing global mean temperature causing agricultural losses and reduced yields, putting stress on food systems.20 Reduced production could impact local food security (food availability) and raise prices locally and internationally (food accessibility). Addressing these challenges with adaptive measures may require all of policy and regulation interventions, adaptation of production practices, and changed practices in processing and distribution, among other interventions.

A key system is the natural environment itself. The natural environment is also under threat from climate change and many of the goods and services that nature provides may be lost if we do not help nature adapt as well. Whereas engineered solutions (or grey solutions) require input of finite resources and are less versatile than nature-based (or green) solutions, working together with nature can regulate water flows, protect shorelines, cool cities, and complement built infrastructure while delivering side benefits for both nature and people.

Currently, climate adaptation is generally viewed as the responsibility of governments. It is considered their duty to protect coastal communities from erosion and to ensure that essential services such as electricity and water continue to be available - although even in developed countries there are already instances where large infrastructure assets are at risk and the question of who should pay for coastal protection is not yet settled.21 At the same time, the global climate finance gap is large and growing.

CLIMATE ADAPTATION

BOX 7. NATURE-BASED SOLUTIONS Nature-based solutions harness the power of nature to reduce greenhouse gas emissions and help us adapt to the impacts of climate change. They are win-win solutions that involve protecting, restoring and sustainably managing ecosystems to address society’s challenges and promote human well-being. Forests are probably the most well-known nature-based solution for climate change, but there are many more - including peatlands, mangroves, wetlands, savannahs, coral reefs and other landscapes.

https://www.bloomberg.com/news/features/2016-08-17/louisiana-s-sinking-coast-is-a-100-billion-nightmare-for-big-oilhttps://www.bloomberg.com/news/features/2016-08-17/louisiana-s-sinking-coast-is-a-100-billion-nightmare-for-big-oil


22 WWF (2016), Landscape Elements: Steps to achieving Integrated Landscape Management. 23 WWF (2019), WWF Recommendations on Adaptation Finance: Building socio-ecological

resilience to climate change.

Two trends are converging that will change this picture: public sector efforts to crowd-in private sector capital through innovative financing mechanisms, and increasing private sector awareness of the relevance of climate adaptation finance. However, broadening ownership of climate adaptation efforts and increasing financing levels will require a higher level of communication and collaboration between the public and private sectors than seen today, and will continue to rise. Climate-aware companies are already using their own resources to safeguard business operations and supply chains against climate impacts. Many financial institutions are implementing measures to identify, measure and manage climate risk in their investment and lending portfolios.

WWF AND CLIMATE ADAPTATION Many of the most biodiversity-rich places on earth are also those where both people and ecosystems are the most vulnerable to climate change. Increased finance for climate change adaptation presents both opportunities and challenges to shaping a viable future for people and nature. Supporting adaptation efforts that focus exclusively on economic and social priorities can result in the unintentional degradation of natural systems and thus undermine long-term resilience of people and their livelihoods. Although short-term adaptation may be achieved with economic and social benefits, depletion of natural capital or threatening the ability of ecosystems to evolve could lead to long-term vulnerability.

WWF advocates the use of landscape approaches as a key element in ensuring the long-term viability of ecosystems. A landscape approach aims to reconcile competing social, economic and environment objectives. An integrated management approach includes managing land in a way that involves collaboration among multiple stakeholders with the purpose of achieving a sustainable landscape. These approaches seek to integrate conservation, sustainable use and where necessary restoration across a whole landscape mosaic to sustain biodiversity and ecosystem services, whilst ensuring room for subsistence and commercial activities.22

WWF also works globally with communities, corporations and governments to drive “social-ecological” resilience. This includes working with stakeholders to prepare national and international adaptation policies, integrating environmental considerations into disaster recovery and reconstruction efforts, integrating adaptation measures into WWF landscapes/seascapes, and studying how ecosystems and species can become more resilient.

WWF has encouraged countries and donor institutions to follow three guiding principles when developing, supporting, and implementing adaptation efforts. These principles are equally important for asset owners aiming to assess the sustainability of a climate adaptation investment or activity of investees.23

CLIMATE ADAPTATION

WWF ADVOCATES THE USE OF LANDSCAPE

APPROACHES AS A KEY ELEMENT IN ENSURING

THE LONG-TERM VIABILITY OF ECOSYSTEMS

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These principles are supported by nine recommendations for adoption during the development, financing and implementation of adaptation efforts. WWF is actively helping partners build social-ecological resilience by supporting climate adaptation that works at the intersection of nature’s needs and people’s needs at a landscape level.

Avoid Harming Nature

Sound adaptation efforts should carefully manage trade-offs, seeking actions that can help reduce vulnerability without undermining valuable ecosystem services that support resilience to climate change in the longer term.

Use Nature To Help People

Adaptation efforts should be aligned with and support broader strategies to incorporate nature’s ability to contribute to addressing other challenges such as sustainable economic development and meeting societal needs.

Help Nature Adapt

Adaptation efforts should look to identify systemic solutions which acknowledge the important role of biodiversity and other natural elements in building resilience by applying climate-informed or climate-smart conservation strategies.

CLIMATE ADAPTATION

AVOID HARMINGNATURE

USE NATURE TO HELP PEOPLE

HELP NATURETO ADAPT

FIGURE 6 WWF RECOMMENDATIONS FOR BUILDING SOCIAL-ECOLOGICAL RESILIENCE TO CLIMATE CHANGE

Imja

Gla

cier

mel

ting,

Nep

al. ©

WW

F /

ST

EV

E M

OR

GA

N

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24 JP Morgan (2020), Risky business: The Climate and the Macroeconomy. 25 National Bureau of Economic Research (2015), Climate Risks and Market Efficiency.

26 IPBES (2019) Global assessment report on biodiversity and ecosystem services of the

Intergovernmental Science-Policy Platform on Biodiversity and Ecosystem Services, Summary for Policymakers.

27 Environmental Protection Agency (n.d.), Ocean Acidification: Changing Ocean Chemistry. Retrieved from https://www.epa.gov/ocean-acidification

4.RISK MITIGATION & VALUE CREATION

A 2020 Special Report by JP Morgan aims to increase awareness on the impact of climate on the economy. The same report notes that “a rise in the [global] temperature will trigger changes in the climate: shifts in patterns and amounts of precipitation (including monsoons), decreases in ice coverage, changes in wind patterns (for example, El Niño), changes in humidity, the greater likelihood and severity of extreme weather events (droughts, storms, hurricanes, cyclones), and changes in flooding and sea levels.”

The evolution of the broader financial system towards investing in climate adaptation is essential, highlighting the critical role of asset owners. Although a strong argument, it is not necessary to rely on moral arguments alone to make the case for asset owners to be part of this systemic evolution and shift in capital allocation. Engaging in climate adaptation offers asset owners the opportunities to both mitigate risk and identify new value streams.

NATURAL CAPITAL AND THE ECONOMY Natural capital is critical for human existence and is fundamental to our economic well-being. Natural capital includes resources and systems such as water, forests, and clean air that enable economic activity by providing businesses with materials, inputs to production, protection from disasters and absorption of the pollution. This link between natural capital and the economy varies from obvious examples of agri-food companies that provide sustenance to industrial companies which require freshwater for their processes. Thus, a decline in natural capital impacts economic activity and affects asset owners directly as many portfolio companies depend on natural capital to operate and to performance targets. One example is the impact of drought on the stock prices of food companies. In a 2016 study by the National Bureau of Economic Research, a (fictitious) portfolio where an investor would have shorted food companies located in countries in drought and would have taken long positions of food companies located in countries not in drought, would have generated a 9.2% annualized return from 1985 to 2015.25

Climate change is among the primary drivers of the decline in the state of nature.26 The increased intensity and frequency of extreme weather events including droughts and floods as well as sea-level rise and ocean acidification exacerbate the already negative trends in the natural environment. These trends have systemic effects on other aspects of natural capital such as biodiversity. Ocean acidification coupled with a global temperature rise means habitat loss for ocean populations and threatening complex ocean food webs.27 The combined loss of physical climate hazards and loss of natural capital such as biodiversity impacts the long-term viability of the economy as companies rely on natural capital to deliver financial performance and societal value.

“IT IS CLEAR THAT THE EARTH IS ON AN

UNSUSTAINABLE TRAJECTORY. SOMETHING WILL HAVE TO CHANGE AT

SOME POINT IF THE HUMAN RACE IS GOING

TO SURVIVE”

JP Morgan24


28 Econadapt (2015), Defining the opportunity costs of adaptation.

THE CASE FOR ADAPTATION Humans and other species have adapted to live in diverse parts of the world with very different climates. The issue now is the pace and magnitude of changes in the global climate. Climate adaptation must therefore become a core strategy for asset owners. If climate change impacts natural capital, and natural capital is essential for the economy to flourish, there is a strong case for asset owners to promote climate adaptation on a systemic level. A systemic approach to climate adaptation must consider risk to nature as well as to physical assets, while assessing the net positive impact with an understanding of potential indirect effects. There is a double win in this strategy: asset owners will mitigate their own risk over time, and can identify new investment opportunities.

The United Kingdom Climate Impacts Programme (UKCIP) suggests that adaptation actions can be classified as either sector-specific through “Delivering Adaptation Actions”; or system-wide actions to “Building Adaptive Capacity”. The diversity and breadth of an asset owner’s portfolio suggests that system-wide actions would be most appropriate. There are two challenges for asset owners in considering a strategy to build system-wide adaptive capacity: indirect benefits may be overlooked if not well defined;28 and, accepting systemic adaptive actions requires re-envisioning the investment time horizon. Despite these challenges, asset owners can still engage in climate adaptation to mitigate risk and create value.

RISK MITIGATION THROUGH CLIMATE ADAPTATION At the heart of risk mitigation is understanding the mechanism of impact, which makes assessment of climate risks a critical step in the risk management process. By identifying how climate hazards trigger risk events, asset owners can identify the most effective adaptive actions.

Typically, climate adaptation offers asset owners the ability to enact loss avoidance or reduce the severity of impacts by increasing resilience on the portfolio level. Yet, many asset owners own a slice of the economy and cannot diversify away from climate change. Such Universal Owners should also pursue a strategy of systemic adaptive actions.

Asset owners can aim for loss avoidance by adapting investment strategies, such as reducing exposure to high-risk sectors or asset classes. Some asset owners are already taking this action by divesting from certain sectors or using shareholder engagements and voting power to influence the strategy of companies. This is particularly the case with the sectors depending on fossil fuels such as oil and gas companies and pure-play coal companies.

In addition, asset owners can look to increase resilience through adaptive action. Asset owners can increase their resilience by, for example, adapting investment policies and decision-making frameworks to incorporate climate risk as a material risk factor. This will better prepare them to respond and build resilience in the face of climate change by developing the ability to react quickly in the face of change.

RISK MITIGATION & VALUE CREATION

A SYSTEMIC APPROACH TO CLIMATE ADAPTATION

MUST CONSIDER RISK TO NATURE AS WELL AS TO

PHYSICAL ASSETS, WHILE ASSESSING THE NET

POSITIVE IMPACT WITH AN UNDERSTANDING

OF POTENTIAL INDIRECT EFFECTS

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29 https://www.ceres.org/resources/toolkits/investor-water-toolkit 30 New Climate Economy (2018), Unlocking the inclusive growth story of the 21st century:

Accelerating climate action in urgent times. 31 Climate-ADAPT refers to these as grey, green, and soft adaptation actions.

If we accept that climate change is a systemic risk that cannot be diversified away, then the systemic adaptive actions that asset owners can pursue would entail working with a wide range of stakeholders including governments and civil society. Recognizing the role of natural capital and the impacts of climate change to natural capital requires that asset owners take a broad view and work through their portfolio companies to manage their impacts and dependencies on natural capital.

A toolbox for asset owners to achieve better outcomes for portfolio companies, people, and nature already exists in part. Through direct engagements or through collaborative platforms such as CERES Investor Water Hub,29 asset owners can work with their portfolio companies to build climate resilience. Asset owners can also use their voting power to build awareness among portfolio companies, and where needed, apply shareholder pressure to take action and build climate resilience.

VALUE CREATION THROUGH CLIMATE ADAPTATION Although viewing climate impacts with a focus on risk mitigation is gaining ground, investing in climate adaptation may also open new streams of value creation with substantial opportunity for gains. There are two ways in which asset owners can get exposure to climate adaptation interventions: direct investment opportunities such as green bonds and real assets such as sustainable infrastructure, or indirect investment opportunities such as investments in companies that are taking steps to become climate resilient.

In 2018, the Global Commission on the Economy and Climate (the Global Commission) produced the “New Climate Economy” report which found that bold action on climate could yield a direct economic gain of USD 26 trillion through to 2030 compared with business-as-usual.30 Some traders are starting climate change themed hedge funds, and climate-focused indexes are arising. Asset owners can take advantage of these new value streams that arise with accelerated growth as the world looks to transition to a climate resilient economy. New value streams may be classified as arising from a blend of three sources: technology development, implementation of nature-based solutions alongside a landscape approach, or as a response to policy, legal, or financial measures.31 Such new value streams will be created in the wider climate-related investment universe, including clean energy, sustainable infrastructure, agriculture, and a circular economy.

Yet, we must ensure that capturing such opportunities does not create significant harm to other climate and nature related goals. For example, purpose-grown biofuel crops may present the opportunity to adapt to changing regulations, but large-scale deforestation with the objective of growing biofuel inputs may negate any reduction in fossil fuel use by also reducing forests acting as natural carbon sinks. It may also have social consequences, contributing to food insecurity where agricultural crops are substituted for biofuel. WWF advocates that investors look beyond siloed individual investments and consider climate risks across landscapes and regions.


BOLD ACTION ON CLIMATE COULD YIELD A DIRECT

ECONOMIC GAIN OF USD 26 TRILLION THROUGH TO 2030 COMPARED WITH

BUSINESS-AS-USUAL

Global Commission on the Economy and Climate

1.https://www.ceres.org/resources/toolkits/investor-water-toolkit


32 AB InBev (2018), Annual Report 2018: Shaping the Future.

Similarly, sustainable agriculture combined with forest protection can allow for adaptation to changing climate conditions while incorporating nature-based solutions, supporting local populations in building resilience to climate related hazards through improved economic status, and increasing supply chain stability for the food and beverage sector. Investing in companies that take these steps to build climate resilience allows exposure to companies generating new technologies with significant market potential such as drought tolerant seeds or establishing improved practices which could offer competitive advantage. For example, some breweries have made real progress in investing in climate smart solutions, including crop diversification and working with local communities to manage scarce water resources. For example, WWF partners with AB InBev in Bolivia, South Africa and Zambia to develop blended finance approaches to encourage private sector investment at the scale required to improve water access and quality, enhance the health of river basins and ensure that the needs of local communities are met.32



5. ENGAGING IN CLIMATE ADAPTATION INVESTMENTS

All countries need to adapt to climate change, the most vulnerable countries may be those in the developing world who have the least capacity and resources to adapt to the changing climate. Many of these countries are not included in the investment mandate of large asset owners. Therefore, it is difficult to get direct exposure to adaptation investment opportunities across the full range. The barriers to private sector investment in developing countries are well known, and include corruption, poor legal, economic and regulatory frameworks, immature financial markets, and currency exchange risks. This could partly explain why many asset owners only have limited exposure to emerging market debt and equity. For developing countries to attract private capital, they often need to work through intermediaries with an investment grade credit rating.

Some of these opportunities do not present themselves through regular channels. It requires asset owners to actively engage with a range of stakeholders, including governments, asset managers, MDBs/DFI’s, and stakeholder groups.

DIRECT AND INDIRECT EXPOSURE There are two ways in which asset owners can get exposure to climate adaptation interventions: direct climate adaptation investment opportunities such as green bonds and real assets such as sustainable infrastructure, or indirect climate adaptation opportunities such as investments in companies that are taking steps to become climate resilient.

This chapter will describe three direct channels to identify direct climate adaptation themed investment opportunities. But, asset owners are indirectly exposed to climate adaptation as well if portfolio companies are unaware or unable to identify and manage climate risks. It is therefore imperative that asset owners work with portfolio companies to reduce their climate related risks by helping them to improve their environmental performance.

For example, water intensive industries such as the beverage industry or meat production face material climate risks. If a portfolio company does not manage these risks adequately and in a sustainable manner, then the company may face fines, have its operating license revoked, or experience reputational risks. This ultimately increases the risk profile of the company, all else being equal. As these risks will increase as climate change will accelerate, investors should take action.

WWF believes that overall, financial institutions engagement holds significant potential for improving sustainability. Divestment should be a last resort. There will be increasing pressure on financial institutions, at least in the European Union, to work with their clients and transition them into a climate-resilient economy.

Reducing physical climate risks in investment portfolios may pose a big challenge. Investors will need high quality climate impact data and need to assess the investees adaptive capacity to manage this risk. In the future, investors can expect that climate risk reporting by companies will improve as the recommendations of the TCFD are being implemented, and other regulatory requirements are adopted, such as the EU Sustainability Taxonomy.

IT REQUIRES ASSET OWNERS TO ACTIVELY

ENGAGE WITH A RANGE OF STAKEHOLDERS,

INCLUDING GOVERNMENTS, ASSET MANAGERS,

MDBS/DFI’S, AND STAKEHOLDER GROUPS


33 Moody’s Investor Service (2018), Research Announcement: Project finance bank loans for green use-of-proceeds projects demonstrate lower default risk.

Thus, investors will benefit by investing in and engaging with companies that develop sustainable adaptation plans to manage climate risks and positively contribute to addressing the global climate adaptation challenge. Companies that are not transitioning could become stranded assets in the future, experience higher capital and operational costs, may become uninsurable or struggle to maintain growth and productivity.

BUILDING NEW MARKETS: THE ROLE OF GOVERNMENT A particularly important role exists for governments. Climate change is caused by more than just a market failure; in particular, attracting private capital for climate adaptation means that governments must lead the way and start investing along the entire innovation chain and define new high-risk directions. There would have been no internet, no nanotech, and no clean-tech if governments had not accepted failure and tackled extreme uncertainty. To address climate adaptation, asset owners should seek deeper levels of cooperation with government agencies and define climate adaptation as a ‘moonshot’ project.

Many climate adaptation projects are not currently commercially viable as stand-alone investments or portfolios. However, governments can step in and design structures through which the private sector can allocate funding in a manner that is commensurate with the principles underpinning their investment mandates. This chapter will highlight several examples where governments went beyond correcting market failures and provided risk capital to crowd in private capital.

According to a report from Moody’s Investors Service,33 project finance bank loans for green use-of-proceeds projects demonstrate a lower risk of default compared to project finance bank loans for non-green use-of-proceeds projects. Many green use-of-proceeds projects have the benefit that they are issued by governments, or otherwise supported by them. This shows that an active role of the government can provide the right incentives to crowd-in private sector funding.

CLIMATE ADAPTATION FOR EMERGING MARKETS Asset owners may have investment mandates which limit their investment into emerging markets. While asset owners may feel they can avoid the higher risk profiles of emerging markets in this manner, if emerging markets cannot adapt to climate, there remains indirect climate risk exposure to all actors in the financial system. To build deep climate resilience, the financial sector must adapt across all markets.

ENGAGING IN CLIMATE ADAPTATION INVESTMENTS

PROJECT FINANCE BANK LOANS FOR GREEN

USE-OF-PROCEEDS PROJECTS DEMONSTRATE

A LOWER RISK OF DEFAULT COMPARED

TO PROJECT FINANCE BANK LOANS FOR

NON-GREEN USE-OF-PROCEEDS PROJECTS

Moody’s Investor Service


34 European Council (2020), Press release. Sustainable finance: Council adopts a unified EU classification system.

35 EU Technical Expert Group on Sustainable Finance (2020), Taxonomy: Final Report of the Technical Expert Group on Sustainable Finance.

Perceived or real, barriers to scaling up climate adaptation investment in emerging markets may include investment mandates, tickets sizes, and risk profiles of investments. Existing channels to engage in adaptation, whether direct or indirect, are often focused on developed nations but can overcome these barriers to scale adaptation finance in emerging markets. Investment mandates may require expansion, or re-interpretation. Large ticket sizes can be managed through aggregation of investment opportunities, or integration of investments across large landscape areas. The inherently riskier nature of emerging markets can be managed through partnerships to develop innovative structures with the use of first-loss capital or other mechanisms to manage risk exposure. By taking a pro-active approach to engage in climate adaptation for emerging markets, asset owners can work towards building systemic climate resilience and thereby limit their own indirect exposure to climate risk, while actively managing direct exposure to emerging markets.

INVESTING IN CLIMATE ADAPTATION: EU TAXONOMY Many financial sector participants have asked themselves whether their investment or lending meets the sustainability threshold and how to contribute to this transition. Lingering uncertainty around what is green and what is not has held back the deployment of capital as no investor wants to be accused of greenwashing.

The EU has stepped into this void to develop a framework to facilitate sustainable investments (a so-called ‘Taxonomy’) that sets new disclosure requirements for a broad range of companies and financial institutions through an EU-wide regulation.34 An EU Technical Expert Group (TEG) on Sustainable Finance released final recommendations35 on climate mitigation and adaptation for the EU Taxonomy in March 2020, which are expected to be coded into EU law before the end of 2020. The EU Taxonomy is one of the key elements of the EU Action Plan, with the purpose of reorienting capital flows towards sustainable investments. It aims to create a uniform and harmonized classification system of what is and what is not a sustainable investment.

While the new disclosure requirements under the EU Taxonomy regulation only apply to European and foreign market participants with sustainable financial activities in Europe, it may also be used outside the EU. Other countries have also started to follow the EU TEG model. The UK has established the Green Finance Taskforce. Canada has set up the Expert Panel on Sustainable Finance and Australia has established the Australia Sustainable Finance Initiative.

For climate adaptation, the EU Taxonomy has identified 68 climate change adaptation activities to guide investors on what falls within the definition of “sustainable”. The EU Taxonomy makes a distinction between two types of adaptation activities:

• Activities that increase climate resilience by integrating measures to perform well in a changing climate;

• Activities that enable adaptation of other economic activities.


1.5°cINVEST BELOW


36 WWF (2016) Green bonds must keep the green promise! A call for collective action towards effective and credible standards for the green bond market.

37 Climate Bonds Initiative (2019) Comparing China’s Green Bond Endorsed Project Catalogue and the Green Industry Guiding Catalogue with the EU Sustainable Finance Taxonomy (Part 1).

The overall goal of the EU is that all sectors must improve their resilience to climate change. This also helps extend the definition of climate adaptation to a broader range of economic activities, if the goal of the activity is to improve climate resilience. Importantly, EU Taxonomy recognizes the importance of nature-based solutions: one of the criteria is that the solutions must “consider the viability of ‘green’ or ‘nature-based’ solutions over ‘grey’ solutions to address adaptation”. In other words, green where we can, grey where we must.

There are increasingly promising channels through which asset owners can become exposed to climate adaptation projects. Three such channels are highlighted below, to which the EU taxonomy provides guidance:

• Adaptation-Themed Green Bonds

• Availability-Based Payments in Public-Private-Partnerships

• Climate-Themed Investment Funds

Adaptation-Themed Environmental Bonds (so called ‘Green Bonds’)

Environmental bonds, also called ‘green bonds’ or ‘blue bonds’ is a fixed-income instrument that is specifically earmarked to raise capital for environmental projects, including climate adaptation. Many institutional investors are already exposed to green bonds where the proceeds are used for climate adaptation: for example, the Nederlandse Waterschapsbank (NWB Bank) has issued more than EUR 10 billion in Green Bonds to date, many of which have been bought by European asset owners. One of the projects that received funding through the NWB Green Bond is an Urban Water Buffer in Rotterdam. This Urban Water Buffer reduces flood risk and makes additional water available in periods of drought.

Currently, overall it is up to the issuer to determine whether a green bond is green, based on international guidelines and standards. As the green bond market gained traction in 2016, WWF signaled that a lack of robust, credible, fully developed and widely accepted industry standards for green bonds was urgently needed.36 Since then several developments have contributed to such standards.

The EU TEG on Sustainable Finance published its Report on EU Green Bond Standard (EU GBS) in June 2019. The EU GBS is aligned with the detailed EU Taxonomy which provides guidance on which projects are considered green or not. The Chinese government has also issued a Green Project Catalogue,37 which is expected to be revised in 2020.


CHANNEL 1


Bank Group (2019), High Level MDB Statement: For publication at the UNSG climate action summit, 22 September 2019.

38 Climate Bonds Initiative (2020) 20019 Green Bond Market Summary. 39 ADB, African Development Bank Group, AIIB, European Bank for Reconstruction and

Development, European Investment Bank, IDB, IsDB, New Development Bank, World

Furthermore, the Climate Bonds Initiative (CBI), a not-for-profit organization that certifies green bond issuances, developed sector-specific Climate Resilience Criteria. A key point is that investments can be ‘asset-focused’ or ‘system-focused’ (or both). The size of the green bonds market has grown significantly since 2016, reaching USD 258 billion in 2019, and is expected to grow to USD 350 billion in 2020. Yet within labelled green bonds, adaptation and resilience is only a small proportion of use of proceeds. According to CBI, the allocation of green bonds to all of waste, land use, industry, information and communication technologies, and adaptation and resilience represented only around 10% of total 2019 issuance.38

One challenge is that not all public issuers which invest their proceeds into climate resilience label the bonds as such. While climate adaptation can be one of the categories for use of proceeds, the bond itself may simply be a Green Bond or even an unlabeled bond. One exception thus far was in 2019 when the EBRD issued a first ever dedicated climate resilience bond of USD 700 million.

The world leader in issuance of green bonds is the European Investment Bank (EIB) with over EUR 26.7 billion raised across 13 currencies as of December 2019. Yet, even where green bonds may contribute to adaptation, the EIB does not apply an adaptation label. In November 2019, the EIB announced their intention to mobilize EUR 1 trillion of investments in climate action and environmental sustainability in the decade from 2021 to 2030.

Green bonds in emerging markets

To address the need for climate adaptation in developing countries through green bonds, the most promising channel through which asset owners can get exposure is through MDBs such as the World Bank, IFC, Inter-American Development Bank. For example, the World Bank, whose clients are largely developing countries and economies in transition, has issued Green Bonds since 2009. Their use of proceeds include protection against flooding (including reforestation and watershed management), food security improvement and implementing stress-resilient agricultural systems (which slow down deforestation), and sustainable forest management and avoided deforestation. In September 2019, eight MDBs announced that they will increase global climate finance to USD 65 billion by 2025, and within this total, double the annual combined climate adaptation finance to USD 18 billion.39


BOX 8. MIAMI FOREVER BOND In 2019 Miami raised USD 400 million in a Forever Bond, a general obligation bond, to finance a range of adaptation measures. The bond will be paid for by an increase in real estate taxes. Thus, this development highlights the two core messages of this report: climate adaptation is both a risk (in this case to real estate investors in Miami) and an opportunity (to investors in the Forever Bond and the companies implementing the adaptation activities).

THE SIZE OF THE GREEN BONDS

MARKET HAS GROWN SIGNIFICANTLY SINCE

2016, REACHING USD 258 BILLION IN 2019,

AND IS EXPECTED TO GROW TO USD

350 BILLION IN 2020

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40 African Development Bank (n.d.), List of eligible projects in the Green Bond Portfolio as of December 2019. Retrieved at https://www.afdb.org/en/topics-and-sectors/initiatives-partnerships/green-bonds-program/portfolio-selection

One example comes from a Green Bond issued by the African Development Bank (AfDB).40 As part of their Green Bond program, the AfDB allocated USD 77 million to a Farm Income Enhancement and Forest Conservation project in Uganda. The project provides necessary resources and inputs to enable farmers increase and manage valuable and profitable vegetation cover in local forest reserves, community forests, natural forests and degraded landscapes. The project will further support apiculture activities (rearing honeybees) within selected watershed areas so that they contribute to conservation of forests and increase the quantity and quality of honey for immediate income generation.

Climate adaptation financing is likely to be one of the major drivers fueling the growth of green bonds in the future. Chapter 6 will provide guidance on what asset owners can do to support the supply of adaptation-themed bonds, or work towards more direct exposure to adaptation in emerging markets.

Availability-Based Payments in Public-Private-Partnerships

There is a perception that many climate adaptation projects are not considered “bankable” because climate adaptation is considered a public good: it is the government’s responsibility to ensure that coastlines (for example) are protected. Traditionally, governments have funded some or all capital investment in such projects. But governments may not have enough capital to finance all climate adaptation projects, or for other reasons (such as efficiency) may want to redistribute the share of risks and responsibilities among stakeholders.

Public-Private-Partnerships (PPPs) bring together the skills and resources of both the public and private sectors with a goal to properly allocate risks according to each side’s capacities. Traditionally, PPPs have been used for infrastructure provision, including transport systems, hospitals, schools, and water and sewerage systems.

One innovation in the PPPs is the emergence of availability-based payment mechanisms. This is similar to results-based payments where an entity (usually the government) pays a provider of services on the basis of the outcomes their service achieves rather than the inputs or outputs the provider delivers. Social Impact Bonds (SIBs) are an example of results-based payments.

In the context of PPPs, availability-based payment mechanisms are long-term contracts where the private sector is allocated for the responsibilities of designing, building, financing, and maintaining (DBFM) a public project. In return for their services the private sector is reimbursed through a predetermined performance-based payment plan.


CHANNEL 2

https://www.afdb.org/en/topics-and-sectors/initiatives-partnerships/green-bonds-program/portfolio-selectionhttps://www.afdb.org/en/topics-and-sectors/initiatives-partnerships/green-bonds-program/portfolio-selection


41 Ecologic Institute (2015), Coastal Protection and Suds – Nature-Based Solutions. 42 Nicholls, R.J., Lincke, D., Hinkel, J. Pol, van der, T. (2017) Global Investment Costs for

Coastal Defense Through the 21st Century.

Within the context of the long-termism of availability-based payment PPPs, there is an increased understanding and appreciation of the role of NBS in protecting the world’s floodplains, urban deltas and shorelines from flooding and erosion. Various types of nature-based solutions for coastal protection exist, including artificial wetlands or salt marshes, beach nourishment, oyster reef creation and mangrove re-establishment and protection. For example, artificial oyster reefs created in New York, USA and the Oosterschelde, Netherlands, achieved both wave reduction and erosion protection.41 Furthermore, NBS have the potential to offer significant co-benefits, such as increased recreational opportunities. Yet, not all examples in this chapter embrace the three climate adaptation principles advocated by WWF to avoid maladaptation. Maladaptation can occur when actions that might reduce short-term social or ecological vulnerability are making people or ecosystems more vulnerable to climate impacts over the longer term. Asset owners are encouraged to work with consortia partners that pursue a strategy of “green where we can, grey where we must”.


Research has shown that protecting the world’s shorelines will require significant investments. Under a business-as-usual scenario of the IPCC (also known as RCP8.5) the total accumulated sea defense costs between now and 2100 is estimated to be between USD 3.4 trillion and USD 9.6 trillion.42 Regionally, most investment will be in developed countries, not because the need is highest but because the tax base allows governments to invest in coastal protection. New approaches will be needed to ensure that developing countries can also benefit from such investments.

BOX 9. PEVENSEY BAY SEA DEFENCE SCHEME The Pevensey Bay Sea Defence scheme in the United Kingdom was the first sea defense project anywhere in the world to be funded as a PPP based on availability payments. Commissioned in 2000, it commits a consortium of companies to a 25 year contract to guarantee a consistent standard of sea defense. It protects 9 kilometers of shoreline, protecting real estate, infrastructure, and an important wetland with Ramsar Convention status. The total amount of funding in this case was relatively modest at GBP 30 million. However, the concept has been adopted in many places around the world. This is in part because of its uptake by bodies such as the IMF and the World Bank.

UNDER A BUSINESS-AS-USUAL SCENARIO OF THE

IPCC (ALSO KNOWN AS RCP8.5) THE TOTAL ACCUMULATED SEA

DEFENSE COSTS BETWEEN NOW AND 2100 IS ESTIMATED

TO BE BETWEEN USD 3.4 TRILLION AND

USD 9.6 TRILLION

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To develop these innovative PPPs requires a collaborative and multi-stakeholder approach where government, private sector, and civil society must work together. In designing the Hondsbossche and Pettemer sea dike project, the government designed a collaborative process which engaged local businesses and environmental groups. As a result, the decision-making process went smoothly and the project did not incur delays, reducing risk to investors.

Although these PPPs work well in developed countries such as the Netherlands and the United Kingdom, they may be more difficult to implement in a developing country context. Such an approach requires educating local governments and other stakeholders to familiarize them with availability-based payment PPPs. Also, many asset owners do not have a mandate to directly invest in many of the countries where the need will be highest. Yet, in bringing together the right mix of partners, including export credit agencies, MDBs, asset owners, civil society, and local governments it is possible to develop similar approaches.


BOX 11. THE HONDSBOSSCHE AND PETTEMER SEA DIKE The Hondsbossche and Pettemer sea dike in the Netherlands supplies a total of 35 million cubic meters of sand to create a new dune landscape. This project incorporated nature-based solutions (NBS) by designing a dune habitat allowing natural deposition of the sand along the coastline. The consortium included van Oord and Boskalis, two of the largest dredging companies in the world. The contract is based on 20 years of maintenance and is worth EUR 230 million.

BOX 10. FUTURE PROOFING THE AFSLUITDIJK Consortia were invited to develop an availability-based payment PPP proposal that would future proof the Afsluitdijk, a large dike built in 1932 that protects the Ijsselmeer in the Netherlands. The project must meet coastal defense criteria while at the same time create new nature, opportunities for tourism and economic activities. The 25-year contract has a net present value of EUR 550 million and was awarded in 2018. The financial partners include Aberdeen Standard Investments, PGGM and APG. These contracts are attractive for asset owners as they have long time horizons (20 - 25 years) and provide a stable cash flow, although there remains project risk if the agreed criteria are not met.


Climate-Themed Investment Funds

In addition to green bonds and availability-based payment-based PPPs, new investment and lending opportunities will emerge as the need for climate adaptation-related goods and services increases, and as companies and countries invest in becoming climate resilient.

Whereas asset owners are already seeing adaptation-themed green bonds enter the market, they may have to be more pro-active when developing availability-based payment based PPPs. The same applies to climate-themed investment funds. It may require asset owners to expand their mandate to start investing in such funds. Yet, two new structures are emerging which offer new opportunities for institutional investors to deploy their capital.

Climate-Themed Equity Funds

The overall sentiment in financial markets is that climate risk is not priced into the valuation of companies. Now some investors are stepping beyond what has been the main investment response to climate change, such as investing in renewable energy. By carefully analyzing climate trends, both on the regulatory side and the physical risk side, investors can select stocks and deliver alpha.

Selecting the investments from a climate risk and opportunity perspective has two elements: firstly, identifying the physical or transition risks that are material to a company; secondly, assessing the company’s capacity and readiness to manage climate risks or identify climate related opportunities.

Physical hazards arising from climate change can include drought, flooding (coastal, pluvial, fluvial), heat and cold stress, wildfires, hurricanes, and changing weather patterns. This could lead an investor to pick stocks related to water companies, or agricultural stocks that provide technologies for climate smart agriculture or irrigation techniques.

The second element relates to whether companies are prepared to capitalize on the opportunities or manage these risks. The TCFD should provide guidance on how well companies score on this metric; however, the quality of climate risk reporting is not yet sufficient to build a strong case. Therefore investors must develop their own opinion through alternative means, for example through analysis of annual reports or active engagement. Some companies are investing in climate adaptation interventions, such as a coffee plantation investing in rainwater harvesting to allow water buffering during seasonal fluctuations. Such investments may lower the risk profile compared to those companies that do not invest in building climate resilience.


BOX 12. VOLORIDGE SUSTAINABILITY FUND A new USD 1.5 billion hedge fund called Voloridge Sustainability Fund was started in 2019 by David Vogel, a predictive modeling scientist. According to the company, “the fund will focus on companies affected by events such as floods, fires and natural disasters; firms that invest in efficient technologies; and electric-car makers and their suppliers”.

CHANNEL 3

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Many asset owners, and their managers, have in recent times built their capacity to address climate risk. One strategy to build up capacity on climate is teaming up with a climate research center. Wellington Management, an investment management firm, created a research partnership in 2018 with Woods Hole Research Center, a nonprofit climate science specialist in the United States. The two organizations use climate science to identify metrics that matter for investing.

Documents

CLIMATE ADAPTATION GUIDE FOR ASSET OWNERS: RISK … · IUCN NL: Romie Goedicke Next Green: Anne-Marie Bor . This report is part of a series in which WWF provides insights and recommendations